Using range of expenses in your profit / ROE estimates?

Using range of expenses in your profit / ROE estimates?

J. MartinPro Member
Rental Property Investor · Oakland, CA · Member since 2011 · 3k+ posts · 2k+ votes

I know many members on BP use the 50% rule as a screening technique.. I was curious if anyone uses a range of estimates for expenses to estimate potential profit, rather than strictly 50% - either while they are prospecting, or after purchase..

For example, do you look at what your profit and ROE would be if your expenses sucked up 60% of your revenue? 40%? Decreased or increased rents? ("Stress testing") I think this is a more realistic way to assess the likely range of outcomes, rather than some "overly precise", but less informative calculations, where I see people estimating they will be earning $129.72/door this year, with a ROE of "approximately" 17.25834%..

I use a spreadsheet with 5 different columns and some have higher than expected expenses/vacancy, or reduce the rents by 10-15% to make sure I can handle less than ideal scenarios while still making a healthy return. For example, I may estimate an ROE of 8-12% (or whatever they might be) before principal paydown and appreciation, but after a plausible range of expenses. And I think my results will fall in that range a good majority of the time.. (approximately 82.7643% of the time.. just kidding!)

I used to only model my expected scenario and the downside risk. But I also do 1 or 2 to the upside now to estimate longer-term returns for some increased rents, which I also think is plausible. I learned years ago that if you only look at the negative, you may miss the boat on opportunities also.. If you don't price in your potential upside, you may lose out on lots of deals to others who are taking into account everything..

But this also gives you the ability to ask yourself, Am I comfortable with returns on the low side of that range if expenses are higher, or rents a bit lower, than I thought originally? Or if the market changes? Am I dependent upon increased rents to make healthy returns? Can I reasonably expect my returns to fall within that estimates the majority of the time? Thoughts? I think @Account Closed if he's got time for the forums..?

1Reply
230 views

Most Popular Reply

Johnson H.Pro Member
Investor · San Francisco, CA · Member since 2010 · 910 posts · 889 votes
12y

@Bill Gulley - Ironic that you chimed in here as both J and I are bank examiners as well. =)

See this reply in the discussion

57 Replies

Jump to latestLatest
  • J. MartinPro Member
    OP
    Rental Property Investor · Oakland, CA · Member since 2011 · 3k+ posts · 2k+ votes
    12y

    @Account Closed , I never stop getting surprised by the new low rates I see! Congratulations! As long as you don't mind the 70% vs 75% LTV, it's a nice bump down on the rate.. Will make it easier to refi w/ lower risk of cash-in later too, even if prices don't shoot up.. And you finally got down to my 30yr fixed rate on my 4plex! lol (have to get, while the gettin's good..)

    Just curious, are you starting to look at longer fixed-rate terms since rates are still so depressed? (or at least asking what the terms are, for curiousity's sake). Bernanke (& Yellen..) can't keep it at $4T forever!

    How high does LIBOR have to be for years 5-10 for you to break even on a 10yr fixed today vs 5yr ARM? I heard ads for some doing 15yr fixed even.. You know I'm a sucker for long-term fixed-rate financing - such a great inflation and cash flow hedge. Like I said in a prior posting somewhere else, why split cash flow from years 5-10,15,XX with the Bank through higher rates if you can buy it yourself today on the cheap? (depending on your hold period.) IMHO, the higher and faster rents go, the higher rates will have to go for the Fed to ease the heating economy (as evidenced by quickly increasing/high rents). So I think there's a natural thief of some of your "excess" future cash flow..

    Anyway, I'll get off my fixed-rate pulpit.!. lol

    Nice deal Minh! Don't forget to write your Thank You letter to Bernanke!! You might owe him a couple lol

  • J. MartinPro Member
    OP
    Rental Property Investor · Oakland, CA · Member since 2011 · 3k+ posts · 2k+ votes
    12y

    @Waylon Themer , there's a lot of competition out here for high-quality CRE (& especially multifamily) with high-quality borrowers. With floods of deposits and few investment options besides loans that yield more than a percentage point or two (coupled with a hot local CRE market in Silicon Valley/South Bay), banks are fighting each other over lower-risk, variable-yield assets..

  • J. MartinPro Member
    OP
    Rental Property Investor · Oakland, CA · Member since 2011 · 3k+ posts · 2k+ votes
    12y

    Here an article about a tower in SF around the corner from my office that is selling for a 3% cap rate, even at 90% current occupancy (not a lot of upside on lease-up, so has to come from rent increases and appreciation..). Obviously, this is a much bigger asset, but an example of investors willing to pay up for prime assets in prime areas with increasing rents and values. I bet the financing the buyer will put on it will be dirt cheap too..

    "At $750 a square foot, it’s San Francisco’s most expensive deal for a stabilized office property in the past year, the person said. The tower at Second and Mission streets, completed in 2000, is 90 percent leased. "

    http://www.bloomberg.com/news/2014-01-07/invesco-said-to-pay-291-million-for-san-francisco-tower.html

  • Investor · San Jose, CA · Member since 2012 · 2k+ posts · 3k+ votes
    12y

    J,

    Add 1.5% for a 10/1 ARM. Add 0.6% for a 7/1 ARM. Too steep of a price to pay. I know you're thankful for being able to lock in 3.25% for 30 years. Your cashflow would be even better once the PMI fell off.

    The LIBOR is low beyond anyone's imagination. I know I owe for a fact that Ben Bernanke big time. I won't just send him a letter. I'll fly to his house, give him a man huge, and even kiss him if I know where he lives. That's how much I owe him. A ton of people owe him. Some just don't realize it.

    I don't know anything about Yellen, but from the rumors, I like what I heard about her.

    The last time I mentioned to you about East West Bank is willing to give me a loan for 2% if I have a $1M in deposit. Just talked to them last week. They said they can do it for 1.75% now. How low can we go? Unfortunately, I don't have the money. :(

    @Waylon Themer

    Thanks for the confirmation. I knew she gave us a fantastic rate.

  • Castle Rock, CO · Member since 2015 · 10 posts · 2 votes
    11y

    "Newbie" here... thanks for the thread, can you clarify "DSCR" for me?? Thanks.

  • Laguna Hills, CA · Member since 2014 · 146 posts · 31 votes
    11y

    @Bill D. 

    DSCR = Debt Service Coverage Ratio

  • Washington, DC, WA · Member since 2015 · 39 posts · 1 vote
    11y

    it is very important for us to deal on a perfect and good property. The property which is having a specific features and nice expenses on real estate. it is good to use the range of expenses in your profit because everyone is having a different range. 

Join the conversationCreate a free account to reply, vote on answers and follow this thread.